Prime Rib's  Instablog

This winter should present an interesting roll of the dice for those both long and short natural gas.

As we all know, the house wins, but in this case, it seems the house is still with the middle east.

While OPEC controls oil prices, in America free enterprise allow us to produce cheap and abundant natural gas. Capitalism wins!

Oh not so fast, our great system leads to an excess amount of natural supply while our economy tanks with the rest of the world.  In the long-run, I'm an optimist, if it proves economic to make natural gas as our primary fuel then we'll do it. It could be bumpy along the way (read: price shocks). There are politics involved, of course, but the markets always win in the long-run.

The resource that will save us, in my view, and well articulated by others, is now found everywhere, natural gas. We should love it. Our heating bills have gone down. But as Americans, let's figure out how to make money from the current situation.

Do we buy or sell short natural gas?

The bear case is as follows: America has introduced horizontal drilling which has unlocked previously untouchable gas resources. Cheap capital now doubt fueled this excess of activity. This has led to a glut that is now approaching 2.7 TCF and is breaching our storage capacity. In my view, the lack of cheap capital and the laws of physics will also resolve it. There is a fundamental fact that if you poke hole in the ground to explore for natural gas, the well will exhibit declining production. These production declines can range from 50 to 75% in the first year. It always has been and will remain, a tough business.

The short case also says that end demand will not be able to absorb this supply because the economy is weak; specifically for industrial demand for natural gas which is significant. I argue that is less so today because utility users represent the majority share of natural gas usage. 

Bears also cite LNG dumping. That source is less than 4% of the natural gas used in USA. I believe America will someday be a net exporter of natural gas.

The bull case: 

The demand for natural gas is highly inelastic and has been so for the last decade. Our country is highly dependent on natural gas already and has increasingly been so.  We have a fixed industrial base and fixed utility base that need natural gas. With the recent decline in price, increasingly more utilities are switching to natural gas. Let's look for a 1-1.4 tcf withdraw season and see how price reacts. Natural gas fueled cars are just upside. 

So what are we seeing now?

The markets are focused on the large supply that exists which is short-sighted in my view. Tomorrow we will receive the new injection data. Operators I speak with and follow are surprised by how long the overhang of gas supply has lasted.

Be patient, the laws of physics are on our side.